Monday, October 15, 2012

EU, UK and US debt strategy is an economic and moral disgrace

With the IMF's admission that the Japanese Model and its related policies like austerity do not work, the Telegraph's Ambrose Evans-Pritchard explained in his column why continuing to pursue this debt strategy is an economic and moral disgrace.
The IMF now admits -- or rather those in the IMF who always feared this outcome are at last able to say -- that this misjudgement goes far beyond Greece. Tightening by 1pc of GDP in rich countries does not lead to a 0.5pc loss of output over two years as thought. 
The "fiscal multiplier" is not the hallowed 0.5 assumed by every finance ministry in Europe. The awful evidence since the global bubble burst in 2008-2009 is that the multiplier is between 0.9 and 1.7, or even higher for EMU's crucifixion belt. 
The model constructed over the long boom years -- and largely drawn from isolated cases, each able to export its way out of trouble -- is dangerously wrong in a 1930s-style excess savings crisis with much of the world is slump. 
Steen Jakobsen from Saxo Bank says the IMF's mea culpa is the "biggest financial story of the year". Indeed it is. The authorities have repeated the blunders of the Great Depression, but with fewer excuses. 
The IMF has now called for a change of course. 
My question is how long until the policymakers in the EU, UK and US change course and adopt the Swedish Model?

This February 11, 2009 Business Insider post by Joe Weisenthal provides some insight (hat tip Climateer Investing ).
Obama himself dismissed the idea that the US could adopt the Swedish model in an interview with ABC 
ORAN: There are a lot of economists who look at these banks and they say all that garbage that's in them renders them essentially insolvent. Why not just nationalize the banks? 
OBAMA:Well, you know, it's interesting. There are two countries who have gone through some big financial crises over the last decade or two. 
Please note the following description by President Obama of the Japanese Model.
One was Japan, which never really acknowledged the scale and magnitude of the problems in their banking system and that resulted in what's called "The Lost Decade." They kept on trying to paper over the problems. The markets sort of stayed up because the Japanese government kept on pumping money in. But, eventually, nothing happened and they didn't see any growth whatsoever.
Japan still hasn't seen any growth whatsoever and it is now well into its third lost decade.

What President Obama described is exactly what has occurred in the EU, UK and US.
Sweden, on the other hand, had a problem like this. They took over the banks, nationalized them, got rid of the bad assets, resold the banks and, a couple years later, they were going again. So you'd think looking at it, Sweden looks like a good model. 
Sequencing of events is important and President Obama doesn't have the sequence right.  Sweden provided a blanket guarantee of all deposits and then it made the banks take the losses upfront on the excess debt in the financial system.

Those banks that could recapitalized themselves either through retained earnings or by tapping the private equity markets.  Those banks that couldn't were resolved.

The Swedish Model is different than President Obama describes.  The critical difference being the emphasis on requiring the banks to recognize upfront their losses on the excess debt in the financial system.

Iceland implemented the Swedish Model at the time that President Obama chose to continue the US pursuit of the Japanese Model.

Iceland showed that by making the banks recognize the losses upfront that they would realize if the government adopted policies to 'foam the runway' so banks could go through the long bankruptcy process, it protects the real economy and the social safety net.
Here's the problem; Sweden had like five banks. [LAUGHS] We've got thousands of banks. You know, the scale of the U.S. economy and the capital markets are so vast and the problems in terms of managing and overseeing anything of that scale, I think, would -- our assessment was that it wouldn't make sense. And we also have different traditions in this country. 
Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country
And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again. 
The record shows there was a) no tough love, b) credit is not flowing again and c) as predicted by your humble blogger the Japanese Model did not work any better in the US than it worked in Japan.
Weisenthal:  We're glad Obama believes so much in capitalism, but we're not sure how propping up banks that otherwise would have gone bankrupt is more capitalist than what they did in Sweden, where the bad actors lost their private status. 
Roger Ehrenberg thinks Obama's answer is total hogwash. 
The punch line: while being creative with statistics, the President dismissed Sweden's (successful) approach to restructuring its banking sector on both economic and ideological grounds. 
His stance that Sweden "only" nationalized five banks, while the US would need to nationalize thousands to achieve the same effect, is both specious and absurd. No discussion of relative GDPs. No comparison of the size of the banks that were nationalized relative to, say, the top 10 banks in the US. It was one of those typical "a politician says it on TV so it must be true" moments, only I'm really disappointed that President Obama is resorting to such tactics to sell the Geithner Plan not a month into his Administration.

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